Monetary policy surprises and the yield curve

This paper presents a theoretical framework that allows a decomposition of 'surprises' along the yield curve at the time of monetary policy changes. These surprises can be decomposed into news about policy variables and news about policy preferences, depending on where along the yield curve these surprises occur. On this interpretation, news about policy variables shows up in movements at the short end of the yield curve and is a signal of imperfect monetary policy transparency. News about policy preferences shows up in movements at the long end of the yield curve and is a signal of imperfect monetary policy credibility. The paper considers empirical case studies of the response of the yield curve in the United Kingdom, the United States, Germany and Italy at the time of monetary policy changes. It finds that the introduction of inflation targeting in the United Kingdom has had a significantly dampening effect on yield curve surprises at the short end. This is consistent with - and illustrates one of the tangible benefits of - the increased transparency of the United Kingdom's monetary policy framework under inflation targeting.